Rick Rule, president and CEO of Sprott US Holdings, provides his insights on today’s junior resource market and the opportunities available to speculators. Rick shares about three places where he is investing his money right now, and also discusses how Sprott approaches providing both debt and equity financing to companies. Furthermore, Rick gives an overview of the upcoming Sprott Natural Resource Symposium, which will be held from July 29th to August 2nd in downtown Vancouver.
Click the link to see the full conference agenda and line up of speakers for the 2019 Sprott Natural Resource Symposium: http://www.cvent.com/d/8gqxxq?RefID=mse19
1:32 Significance of St. Barbara’s buyout of Atlantic Gold Corp
5:04 Three places Rick Rule is currently investing his money
10:30 US-China trade war and where speculators might profit as a result
14:25 Is Section 232 bullish for commodities other than uranium?
16:54 Discussing why and when Sprott provides capital to companies
20:28 How Rick Rule approaches investing in late-stage development plays
25:02 Overview of the 2019 Sprott Natural Resource Symposium
Bill: St. Barbara’s recently took out Atlantic Gold for a 40% premium to what Atlantic Gold was trading at in an all-cash deal. Is there any greater significance to this event for the resource sector at large?
Rick: I think three important lessons from this. The first is that despite a malaise in junior resource equity markets, with the TSXV resource index off by almost 87% over six years, the management team at Atlantic Gold during that same period of time took a 25-cent stock to a buyout at $2.90, which means that for the right people, bad times are in fact good times. The lesson here is to pay particular attention to the teams that you’re investing and speculating in. Most of the good news that’s generated in the resource business is generated by a small number of very high quality people. People always come first.
The second thing I think that bears watching with regards to this, is the increasing influence of Australian mining companies on a global basis. Many North American speculators don’t know this, but there’s a full-fledged mining and exploration bull market going on in Australia, while our markets are in malaise. This has happened, I think, as a consequence of Australian companies being more interested in profitability than narrative. They were helped, of course, by the falling Australian dollar, where you sell the product in US dollar terms but you pay your costs in Australian dollar terms, which have fallen relative to the US dollar. It’s also been true that the Australian mining companies focus much more on utilizing capital employed to generate profitable operations, and hence, that mining industry is much, much healthier and has much, much lower costs of capital relative to us.
The third is simply the growing internationalization of the mining business. Australian investors backed by European capital buying Canadian assets, this is really becoming a global industry, and speculators who don’t pay attention to all three of those lessons will miss out in the upcoming precious metals and base metals, I think, exploration bull market.
Bill: When you see these takeouts and when you’re invested in the development company or early-stage production company that gets taken out, do you prefer an all-cash buyout like this one, or would you prefer a share-for-share deal?
Rick: I’m less fussy, frankly, if I really like the acquirer. I probably personally prefer share-for-share for two reasons: a well-constructed merger often in the long term benefits the acquirer as much as it benefits the shareholders of the acquired company. Of course, if it’s structured correctly, it defers the tax liability, meaning that I don’t pay the capital gains tax until I sell the shares of the company that has acquired the company that I originally invested in. The truth is, in a bad market like this, a 40% premium is welcome at any point in time. More importantly of course, you know Atlantic Gold was a Sprott-backed company all the way from 25 cents a share. For us, the fact that we enjoyed an 11-fold gain over eight years in a very, very, very hard market means irrespective of the way we’re paid, we’re happy to be paid.
Bill: At the Sprott conference last year, you had said to me in that interview that there’s a lot of money to be made for those who know how to play the M&A game. Then when I met you at PDAC a few months ago, you told me you were deploying some of your capital into quality royalty and streaming plays. Are those still the two best places for speculators to put their money now, would you say?
Rick: I’m putting my own money in three different arenas. The first is, as you suggest, playing the mergers and acquisition game, and I’m trying to play it in two ways. I’m trying to find assets that are strategic to other people, that is, assets that almost have to be bought in the next two years, Atlantic Gold Corp being of course a prime example of that. The other way I’m playing the game is I am trying to figure out which vehicles are controlled by high quality people that will be able to take advantage of the cast-offs from big companies. As an example, Randgold and Barrack merge, they lower the cost of acquisition by selling assets that aren’t strategic to them. While those assets might be irrelevant to a company the size of Barrack, they enable smaller teams to build large companies very, very rapidly.
Early in my career, not so early in my career, but 20, 25 years ago, the fallout from acquisitions was used to build each of Silver Standard, Pan American, and Lumina Copper. In those three circumstances, backing companies that acquired assets cast off by majors resulted in Silver Standard going from, if my memory serves me correctly, 72 cents a share to a high of $45. With regards to Pan-American, 50 cents a share to a high of $45. The granddaddy, of course, Lumina, from 50 cents a share to, if my memory serves me correctly, and it might not, $160 when you accounted for all of the transactions that took place after that.
One of the things I’m really looking to do is find the vehicles that high quality teams will use to aggregate assets cast off by majors in the context of this M&A cycle. The second thing I’m doing is, as you suggest, buying the shares of the royalty and streaming companies. I think this gives you low risk beta, they will participate the way that the market moves when the market moves well, but in the interim, they offer up a much lower risk way of participating in the business. They’re regarded by many analysts as overpriced relative to the sector, which I disagree with.
It’s true that they trade at a higher enterprise value to EBIT basis, but I think that’s a consequence of the fact that they have no sustaining capital requirements, and they’re operating on 65 or 70% profit margins relative to the sort of 10 to 15% margins common in other aspects of the mining business. Better businesses trade at better premiums. The important thing to know about the streaming part of the business is that while many analysts believe that their growth periods are behind them because the transactions that they did will become less common in the future, I believe that their growth period is in front of them, and I believe it’s in front of them for two reasons.
There is a shortage of development capital and acquisition debt capital available to non-investment grade companies. The Basel Three Banking Accords made it difficult for the chartered banks, the project banks to participate in those sectors, and streaming has become a very important part of the capital deck in both mergers and acquisition, and also mine finance. These businesses are growing, not contracting. Secondly, there is an arbitrage in the market where precious metals byproduct cashflow in base metals’ mines gets priced at a base metals cashflow multiple, which is sort of from five to seven times in the case of, say, copper or zinc companies. By contrast, those same revenues stripped out and put in a streaming company could enjoy 12 or 13 times multiples, so there’s this amazing arbitrage in this cashflow where big transactions can take place that benefit at once the buyer and the seller. The seller gets a lower cost of capital, the buyer gets an accretive transaction. When you have the opportunity to have very large transactions that are accretive to both parties, those transactions will take place.
Finally, I’m interested in the renewal of generative exploration. Every major mining company in the world is beginning to increase their exploration budget fairly dramatically. The way to play that game historically among the juniors has been among the prospect generators, the people who use their technical and commercial acumen to generate investment targets, which they then joint venture to larger mining companies. The three things that I’m doing with my money are mergers and acquisition strategies, royalty and streaming companies, and generative exploration through prospect generators.
Bill: There’s a trade war between the US and China right now, and as you observe it, where would be some potential places as a speculator where you think you can profit the most?
Rick: That’s a good question, and the truth is I’m sort of stumped for an answer. Trade wars make everyone poorer, tariffs are taxes. My only hope is that saner heads prevail. It is certainly true that as an example, despite the fact that we are likely to have production shortages, a deficit in copper, that the copper price has been depressed and the shares of copper mining companies has been depressed as a consequence of the expectation of reduced economic demand, which is itself a consequence of fears of trade wars. If these trade wars don’t materialize and if we see continued global economic growth, I think that the real beneficiaries of that will be base metal companies which are leveraged to price increases in each of copper, nickel and zinc.
Bill: What about the rare earths? I read two articles today, one saying that China might cut their exports to us of rare earths. “Us” being the USA, you and I are both US citizens. Then the US is saying, “Well, maybe we would put tariffs on the rare earths.” Do you think that we could see a rare earths boom out of this?
Rick: I think the narrative around rare earths is spectacular, meaning that I think that there could be a speculative boom in rare earths. You’ll recall that 10 years ago, we had a rare earth boom. What we learned was that rare earths aren’t rare, the Chinese backed off of their prior attempts to constrain supply because as we began to explore terrain around the world looking for rare earths, we found how un-rare they were. Now, the fact that long term reality doesn’t often jive with near term narrative means that the story around rare earths is probably pretty attractive, not many investors exist who have lost money on metals that they can’t pronounce.
The speculative appeal of rare earths, we don’t have to talk about geology, but rather you can put a picture of an electric car with a pretty girl in a booth and attract capital to something that the management team couldn’t hitherto spell, is an age old form of extracting capital in the mining business. Long term or longer term based on reality, the reason that the Chinese have dominated the rare earths business is that they’re the world’s largest and lowest cost, most efficient producer. If they obviate that advantage by obliterating their pricing umbrella, that is if they raise prices to the extent that Brazilian deposits, Congolese deposits, Canadian deposits, Australian deposits, Mongolian deposits and Russian deposits come into production, the Chinese themselves will learn just how un-rare these rare earths are.
Bill: Section 232 of the Trade Expansion Act of 1962 has been in the news, especially for uranium investors and speculators. For the listeners that aren’t aware, what this section of the trade act does, it gives the president of the United States the ability to impose restrictions on certain imports based on the affirmative determination by the department of commerce that the product under investigation is being imported into the US in such quantities or under such circumstances as to threaten or impair national security. Rick, outside of uranium which I’ve heard you speak a lot about, are there any other commodities that you think that this would impact in a bullish manner?
Rick: Well, in a bullish manner-
Bill: Or that the speculator could profit from.
Rick: I think uranium is probably the most likely, frankly, and you know I’m on record of saying I think it’s horrific policy, although it would benefit me personally because of my shareholdings in US uranium stocks. The truth is that this sort of idiocy, protectionist tariff-intensive policies always can benefit small groups of people at the expense of society, so should the United States decide to protect a non-existent rare earths industry in the United States, I’m sure there are some ironically Canadian listed penny dreadfuls with US rare earth deposits. I don’t happen to know what they are because I’m not attracted to the theme, but the truth is that this is a very, very, very big theme.
Returning to uranium for a second, of course the United States has a reasonably well-developed junior industry in the uranium business, which would do well if Trump decided in favor of the 232. While I don’t approve of that action, I don’t think that we have a strategic interest in uranium. I personally believe that the Canadians and the Australians, among others who are anything but a threat, would keep the United States well supplied with uranium if the 232 legislation was implemented by the president. My suspicion is that the market would reward US-based producers extravagantly.
Bill: I was recently talking to a CEO of a mine finance company, and I was asking him about the number of deals he does relative to the number of deals he looks at. As I did the simple math after he told me, it was about 2.8% of deals that he looks at he actually provides financing for. With Sprott financing, I’m curious, when you’re looking at these projects, what percent of the projects, when you’re going to offer debt financing, do you actually, of the deals that you look at, do you actually provide the financing for?
Rick: On the debt side, it’s pretty good. People are pretty familiar with our investment criteria, and frankly, most of the debt deals that we do we originate, meaning that we have approached the issuer rather than the issuer approaching us. My suspicion is that we probably fund 20% of the transactions that we look at on the debt side. The equity side is very different. The equity side, we get bombarded by inbounds all the time from around the world, and my suspicion is that 2% is probably an accurate number for us as well, that is 1 in 50 transactions that we’re offered that we look at, we come to terms on.
Bill: If an issuer approaches you and Sprott gives that issuer the “no”, you know, “We don’t want to invest in your company or your exploration project,” how often do you actually get flipped and that “no” gets turned into a “yes”? And what would be the dynamics or the inputs that you would receive that would change an initial “no” to a “yes”?
Rick: Well, on the lending side, as an example, we’re highly unlikely to lend on a preliminary economic assessment, we want a bankable feasibility study. If we said no to a PEA and a company spends another 25 or $30 million tightening up the reserve and giving us a more comprehensive document, it’s pretty easy to take us from a no to a yes. You just have to show us how we’re going to get our money back. There are often circumstances where an opportunity, an exploration opportunity is presented to us on the equity side and there isn’t sufficient data available to make a decision. A drill hole, the third dimension can change all that. It is a truism that stocks are often cheaper at $1 than they were at 40 cents, because you have better data to ascertain value after a drill hole has been drilled and the stock has gone up.
In other words, the certainty is such that you are more than compensated for paying up for the stock. There have been many, many, many times in my career where opportunities have been presented to me where I like the people, I like the project, but I didn’t have sufficient data to make the investment. Then later, when the information available to me changed, my decision changed too.
Bill: It wasn’t the persuasion of the salesmen, it was always third party empirical, provable data?
Rick: Yeah, absolutely. I mean, there was a point in time in my career when I was probably more susceptible to narrative than now. At age 66, you know I’m not afraid of missing things. Buffett famously said that investing is like a game of baseball with no called strikes. If the pitcher gets one past you, it doesn’t matter. What you do is stand at the plate and wait for fat pitches, and that’s sort of the way that we invest. We look for circumstances where we believe that the juxtaposition of risk to reward on a project basis, not a market basis, but rather on a project basis is in our favor, and then we invest.
Bill: Before we talk about the Sprott conference, I’d like to get you to share your thoughts on what you look for in late stage development projects. When you’re looking at a PFS or a feasibility study, a definitive bankable feasibility study, assuming you agree with all the assumptions and the inputs that those studies use, do you have a minimum required after tax internal rate of return that you look for?
Rick: Yeah, absolutely. Most PEA’s and BFS’s are done using unrealistically low discount rates. The cost of capital for a non-investment grade issuer for project debt is 15%, and the idea that the issuer comes to you using an 8% discount when his or her cost of capital is 15% is pretty silly. We’re looking for 20% IRRs, assuming a 15% discount rate. The second thing that we’re looking for, assuming, as you said, that the assumptions and inputs that went into the study are consistent, is we’re looking for a team that’s done it before. We are looking for teams that exhibit in-place expertise relative to the task at hand. As an example, if the idea is to build a gold mine or a silver mine in Mexico, we look for teams that have built gold mines or silver mines in Mexico. In other words, we are looking for the expertise in place to execute on the task at hand. Those two things are really what we’re looking for.
Bill: I’m interested on your observation from your 40 years of resource investing. We all know the life cycle of a junior mining share, where it comes out of that dormant phase where it’s ignored, and the permitting phase, and then when it gets into production there’s a ramp up in the share price upward. When you’ve invested in late stage development companies, and you said to yourself, “This looks like a good project,” you put your money in there, how many of those late stage development companies over your course of four decades actually became producing mines? Do you have a rough estimate of that number?
Rick: My guess would be 80%. You know, we’re fairly picky about the ones that go in, but we’re also fairly patient. If we see a late stage development company that’s in the period of time where they aren’t generating news that excites others, we are perfectly willing to understand if the pre-development phase is going to be a year and a half, and then the construction phase is going to be a year and a half, but we think that the value generated is going to be sufficient for the wait. We’re perfectly comfortable waiting three or three and a half years, we are perfectly comfortable too if we think that a stock is worth $3 or $4 and we buy it for $1.25 and it falls to 90 cents, we’re perfectly comfortable buying more.
The willingness to pay attention to value rather than to price and the willingness to understand the time frames involved in pre-development and development is critical if one is going to play this game. If somebody has trauma holding stock over a long weekend, and if somebody makes decisions concerning value based on price, they’re going to be very unsuccessful in the sector.
Bill: Generally speaking, when you invest in a late stage development play, are you planning to sell out in the liquidity of that company after it goes into production, or do you plan on keeping your investment in that company?
Rick: It really depends on what the market gives us. We believe that money is made principally in the delta between perception and reality, perception being the share price, reality being our estimate of value. If we see a circumstance where, as an example, we think the company upon completion will be worth $5 share, if it as a consequence of markets at the time sells for $3.50 a share, rather than selling, we’ll buy more. If by contrast, that same company is selling for $7 a share and we think it’s worth five, we will likely be sellers. It’s the delta between, as I say, perception and reality, price and value that determines our action.
Bill: We’re about two months away from the conference that you host and run there in Vancouver at the end of July, early August. Can you give us an overview of what’s going to occur? What are some of the unique things that are going to occur at this year’s conference, relative to previous years?
Rick: I’m delighted to say that through the resource bear market that we’ve endured for the last six or seven years, this conference has grown every year, which says something about the utility offered up by the conference to speculators and investors in the natural resource sector. Last year was a record conference for us in terms of both attendees and revenues, and this year is on track to be bigger, perhaps substantially bigger than last year’s conference. I think that’s true for a variety of reasons.
First of all, we work very hard on our speaker selection. Our speaker selection is really based on feedback that we get from prior years’ attendees. The speakers that we have include newsletter editors who reach over a million paid subscribers, thought leaders, if you will, in natural resource investing worldwide. We also like to have some big picture commentators on the markets and the political economy. This year, just by way of example, we’re having Jim Rickards back as a guest who’s been with us for many years, but he’s joined by Nomi Prins, a well-known financial journalist, and Danielle DiMartino Booth, a former member of the Dallas Fed, a great big picture commentator.
In addition to that, I think what really sets us apart from some of the other conferences that also have big picture thinkers, is we have always featured entrepreneurs who have built multi-billion dollar mining companies from scratch. It’s important to listen to these people, because they tell you about the lessons that they learned building companies, and how those lessons governed their own individual investment processes, and how you can incorporate that knowledge and those lessons to make you a better natural resource investor. It’s really fun walking through the exhibit hall and trailing, as example, a Ross Beatty or a Robert Friedland, see who they’re talking to and listen to the questions that they’re asking.
I think the other thing that sets us apart from the other conferences that I’m aware of, is that our attendees have told us for years that they consider our exhibitors to be content too. In most conferences, exhibitors are regarded as advertisers, and the qualification to be an exhibitor at many conferences is a pulse and a check that cashes. We feel very differently. In order to exhibit with Sprott, your equity, your share has to be owned in a Sprott managed account. The Sprott managed accounts manage money on behalf of Sprott and its partners too, which means that every exhibitor at the Sprott conference will have been vetted by Sprott personnel and will have passed the test well enough that our money is invested in that exhibitor.
Sadly, that doesn’t mean that the share prices of every exhibitor will go up, but it does mean that you’re getting a curated collection of mineral and oil and gas exploration companies, ones that have passed a fairly stringent test. We think that a combination of intelligently selected speakers, mining industry entrepreneurs, and ultra-high quality exhibitors is what has made this conference an ongoing success in a very difficult market.
The final comment I might have, is that attendees will be in the company of 700 other sophisticated high net worth speculators. The idea that all of the intelligence in the room emanates out from the dais to the crowd is silly. The truth is that there will be numerous attendees there who manage on their own behalf multi-million dollar portfolios, and comparing notes with those people and listening to the questions that they pose in workshops or in the general session, or better yet, in the exhibit hall, can yield very, very valuable insights to other attendees. I would encourage people to literally mix and mingle.